Part 2: Our possible solution to principal reductions

Below is part two of our two-part series examining the decision not to use principal reductions as part of HAMP modifications. Rather, Keith Gumbinger, vice president of HSH.com, has developed what he thinks is a fairer concept for a principal-reduction strategy, one which would still provide meaningful debt relief that is needed.

Instead of offering a principal reduction today–when home values are arguably at their lowest and the cost to the taxpayer could be the largest–defer any principal reduction until the home is sold. If the principal reduction is even still needed–that is, if the homeowner is underwater at the time the property is sold–the principal reduction could take place at that time as part of a streamlined short-sale process. If the home is not underwater, there would be no reason for principal forgiveness or a short sale.

Would some homeowners “dump” their properties simply in order to get debt forgiven?

That would be unlikely, given that these would be homeowners who engaged in HAMP modifications in order to keep their homes from foreclosure and retain a place to live. Although a HAMP modification would generally provide a lower interest rate on their loan (creating a “loss of expected interest income” to the investor), they would at least be responsible for trying to pay back the amount they borrowed.

In effect, the borrower can still benefit with a HAMP modification–getting a lower mortgage rate, improved loan terms and a reduced monthly payment, not to mention the considerable benefit of keeping their home–but will receive no “reward” of a reduction in debt simply because they might have bought a home when prices were high.

What DeMarco should have done

It seems to us that rather than refusing principal reductions outright, Mr. DeMarco might have countered with an expedited-short-sale arrangement that reduces principal at the time of a sale.

So, instead of allowing principal reductions today, we could offer them to HAMP borrowers should they need to sell their home. In turn, Fannie Mae and Freddie Mac would agree to forgive the difference between the sales price and the amount owed, and will waive the right to pursue any deficiency judgments.

For borrowers with assets to draw upon, a forgiveness of a larger amount might be done in exchange for the homeowner making up some of the gap between the mortgage amount and the sales price. This kind of arrangement is essentially an expedited short-sale process and consistent with the GSE’s new short-sale policy.

Home prices could help limit losses

Although not much the case at the moment, home prices will generally tend to rise over time, gradually helping to limit losses incurred by the GSEs (taxpayers). All eligible borrowers will still be able to access relief under HAMP, and homeowners will still reap the benefits of a reduction in their home-related debt at the time the home changes hands.

Forgiving principal tomorrow accomplishes several things:

It may reduce or eliminate a loss for an investor who owns the loan (e.g. the taxpayer)

It provides meaningful debt relief for a borrower who would be otherwise “trapped” in a home, or who might face a large obligation in a short-sale transaction

It provides no additional incentive to “strategically default” in order to get debt relief

So instead of flat-out saying no to principal reductions in conjunction with HAMP, perhaps allowing them at the time of a home sale would be much more beneficial to everyone involved.

No thanks not interested in doing any short sales that help banks or gse’s. F Them. We will walk away whenever that time comes, and since were massively underwater due to so many fraudclousres in our area we will be underwater for the next decade and have plenty of time to walk and do damage to the banks and gses who caused this problem with their desire to deregulate and sodomize the middle class. Keep spinning it how ever you want but out here in the real world everyone knows who did what to who, who got bailed out and who got left behind to deal with the aftermath. Don’t expect those of us in this situation or anyone who’s gone thru the fraudclosure process (oops maybe I should call it the foaming process like obamas man geither calls it) to ever forget what happened, or to trust in this rigged, pro wall st, system ever again. That goes double for our kids.

I agree 100% with cas. The worst decision I made in my life was buying a median priced home with 20% down in 2006, not knowing the mortgage market was so full of fraud. Today, my $60,000 down payment is gone and I’m $90,000 underwater. And now many us underwater homeowners are actually referred to as irresponsible home buyers who don’t deserve relief or mortgage revaluation. WTF?????????

Foaming the runway for TBTF banks really is the only concern of Obama, Democratic and Republican parties. I’m preparing to walk and take another 10% off neighborhood values. That or wait until year 2025 to regain value in this home. I question whether ill ever own a home again… which is a loss to the middle class of this country.

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About the HSH Blog

HSH.com's daily blog focuses on the latest developments in the mortgage and housing markets. Our mission is to relate how changes in mortgage rates and housing policy, as well as the latest financial news, impacts consumers, homebuyers and industry insiders alike. Our 30-plus years of experience in the mortgage industry gives us an edge as we break down the latest changes in an ever-changing market.

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Tim Manni

Tim Manni is the Managing Editor of HSH.com and the author of their daily blog,
which concentrates on the latest developments in the mortgage and housing
markets.